Welcome to this edition of The Derivatives Show on CNBC-TV18. The basic rule of investing is being aware of one’s capacity for risk and the derivatives market offers a plethora of choices for risk profiles of every kind. Join Jitendra Panda, business-head broking, Capital First as he reveals some of the basic strategies that will enable you to harness the choices that Options offer.

Below is the edited transcript of the show on CNBC-TV18

Q: Let us start with Calls first. If you are going out to buy a Call, what is the view that you should be certain of?

A: When you are buying a Call, it means you are bullish in the market. Your view bets that the markets are going to go up. But then why you are buying a Call? because you want to limit your risk. Options are ideal instruments to control risk. So if the market doesn’t go up, you only lose the premium.

So this is the most basic strategy to begin with. First, you have to be bullish and you should be able to pay the current market premium.

Q: How do you decide on a strategy —the right price for a particular call?

A: The first factor that needs to be decided on is the timeframe. All options call for bets on the market reaching a target within a timeframe.

The next item on the agenda is the target level. If you are a buyer, you will have to set the targets. For example, Reliance Industries Ltd (RIL) is at Rs 900 and you believe that in the next 10-15 days, RIL will move up by another Rs 20-30. So you have set a target that in the next 15 days, Rs 30 is the targeted upside on RIL.

The last decision is to go and buy a Call option below the target of Rs 930 to allow you to make some returns if the market moves according to your forecast.

Q: When does one decide to exit a Call option? What is the break-even or the profit point that an investor should always keep his sights on?

A: Before an investor focuses on setting the target level, he has to be aware of the breakeven points. For example, you have bought a Rs 900 Call option with a target of Rs 930 and a premium of Rs 15. So you know till Rs 915 —if the market expires on last day at Rs 915 — you are going to get your premium back. If it expires at Rs 920, you get Rs 20. So breakeven is the strike price plus the premium that you have paid.

Now you have to set stop-losses as it is difficult to predict the market. So, you need to set a stop-loss, based on your risk appetite, if the target level falls below the premium you have paid. This will allow you to exit if the market is not moving as you have predicted.

Q: What are the strategies that a seller must adopt?

A: The Call writer or seller may get only the premium. That is the maximum profit he will make. However, his risk is unlimited. Now the question arises: Why does he sell? If a buyer was bullish, a seller is bearish. He believes that the chances of market coming down are very high. He wants to straightaway pocket the money and restrict his risk to the minimum.

Q: Tell us about Puts. What is the view that investors need to keep in mind and what are the strategies that need to be adopted?

A: What holds good for Calls, holds good for Puts too. The only difference is that the buyer instead of being bullish, is bearish. The risk is limited and returns are made when the market comes down.

Theoretically, profit is unlimited for a Call buyer but it is limited in the case of a Put buyer because the market cannot go below zero.

Q: At what level should a Put buyer set his stop loss if the market does not take the direction on which he has bet on?

A: Whenever you buy a Put or Call option, you need to keep your stop loss according to the value and time. If the market does not move as estimated in five days, then an investor must exit to avoid incurring losses.

Q: What is the maximum extent of risk involved for a Put writer?

A: Risk is unlimited for the Call and Put writer. He can exit during the market hours and shift his position to somebody else. But most writers wait till expiry.